Follow the risk hierarchy
Choose size last. The stop comes from the structure, and the loss limit comes from your independently chosen risk policy.
- 01Thesis
State what must remain true for the trade or investment to exist.
- 02Invalidation
Name the observable evidence that proves the thesis wrong.
- 03Stop
Place the exit beyond invalidation with realistic room for execution.
- 04Unit risk
Calculate the currency loss for one share, contract, or spread at that stop.
- 05Size
Divide the maximum planned loss by unit risk and round down to a valid quantity.
- 06Portfolio heat
Add correlated open risk before approving any new position.
Calculate position size from the stop
The generic formula works only when the instrument value, contract multiplier, fees, slippage, and gap risk are represented correctly.
Maximum planned loss = independently chosen risk limit
Stop distance = absolute value of entry − stop
Unit risk = stop distance × instrument point value
Raw quantity = maximum planned loss ÷ unit risk
Final quantity = round down, then recheck fees, slippage, gaps, and liquidityUnderstand the 3:1 gate
Three-to-one means the planned reward is three times the planned loss. It is a screening gate, not a forecast that the target will trade.
| Win rate | Average win | Average loss | Expectancy before costs |
|---|---|---|---|
| 25% | +3R | −1R | 0R break-even |
| 30% | +3R | −1R | +0.20R per trade |
| 40% | +3R | −1R | +0.60R per trade |
| 50% | +3R | −1R | +1.00R per trade |
Measure combined and correlated risk
Five positions can be one trade wearing five ticker symbols. Add open risk by theme, direction, asset, and catalyst before you call the book diversified.
Add the loss at each current stop across all open positions.
Group positions that depend on the same index, sector, factor, commodity, crypto asset, or event.
Stress gaps and volatility expansion instead of assuming every stop fills at the planned price.
Include options delta, leverage, and nonlinear exposure when the payoff is not share-like.
Reduce new size when one thesis already dominates the portfolio.
Install drawdown circuit breakers
A drawdown plan written while calm is more useful than a promise made after the account is already under pressure.
| Loss from peak | Gain needed to recover | Process response |
|---|---|---|
| 10% | 11.1% | Review execution and reduce uncertainty before adding risk |
| 20% | 25% | Cut exposure, test whether the regime or edge changed, and narrow the playbook |
| 30% | 42.9% | Pause discretionary expansion and complete a formal system review |
| 40% | 66.7% | Capital preservation dominates recovery attempts |
| 50% | 100% | The recovery burden has doubled the required capital growth |
Treat passing as a position
You do not owe the market a trade. Cash, observation, and smaller exposure are valid decisions when the evidence or risk is incomplete.